Metropolitan News-Enterprise


Wednesday, June 22, 2005


Page 1


C.A. Upholds Discipline for Auditors Blamed in O.C. Bankruptcy


By KENNETH OFGANG, Staff Writer/Appellate Courts


The state Board of Accountancy had ample grounds to discipline accountants whose failure to adequately audit the Orange County Investment Pool may have contributed to the county’s bankruptcy, the Court of Appeal for this district ruled yesterday.

Justice Madeleine Flier said three employees of the “Big 4” accounting firm KPMG were grossly negligent in, among other things, accepting assurances from officials in the Orange County treasurer’s office that proper procedures were being followed in connection with the handling of funds invested in the pool by the county and other local agencies.

The county lost $1.7 billion when its investment pool collapsed in December 1994 and it was forced to seek bankruptcy protection. Then-Treasurer Robert L. Citron was convicted of faking interest earnings and falsifying accounts, pleading guilty to four felonies.

KPMG had found no problems in its 1992 or 1993 audits and was close to certifying the 1994 books when the pool collapsed as a result of what the county later called a “massive wager” by Citron and Assistant Treasurer Matthew Raabe that interest rates would remain low. When interest rates began to rise in the spring of 1994, the value of securities posted by the pool as collateral began to decline, lenders started calling in collateral, and the value of the pool’s holdings began a steep decline. 

KPMG  which won the audit contract with a bid of under $100,000, ultimately paid $75 million to settle the county’s civil suit.

Expensive Investigation

After an investigation that cost more than $4 million—or about 17 percent of what it spends in a year—the state Board of Accountancy disciplined the firm; the “engagement partner” for the audits, Margaret Jean McBride; and fellow auditors Joseph H. Parker and Bradley J. Timon.

KPMG received a stayed suspension and a year’s probation, and was ordered to reimburse $1.8 million of the board’s investigative costs. The three individuals were also given stayed suspensions and placed on probation, including a three-year probationary period with a community service requirement for McBride.

The board said the auditors cut corners, ignored warning signs, accepted assurances from county officials at face value rather than maintain the skepticism expected of independent auditors, did not independently test to determine whether laws governing public investments were being complied with, and falsified a critical document to make it appear that it was prepared earlier than it actually was in order to create the appearance that the pool’s investments were less risky than they actually were.

The board’s findings and decision largely tracked those of an administrative law judge, except that the ALJ would have limited the company’s penalty to a public reproval.

KPMG blasted the board’s decision when it was handed down, calling it “an appalling attempt at political face-saving after [the board]invested millions of dollars on a prosecution against us that should never have been brought in the first place.”

Los Angeles Superior Court Judge David Yaffe denied the auditors’ petition for a writ of mandate, saying the board had treated the auditors fairly and that his independent review of the evidence supported the decision.

Flier, writing for the Court of Appeal, said Yaffe’s ruling was consistent with the law and supported by substantial evidence.

The justice also rejected the claim that the firm and its employees were denied due process as a result of the board’s financial stake in recovering its costs.

Flier acknowledged that an administrative factfinder’s financial interest in the outcome of a proceeding must be viewed with alarm. But the procedures applicable to the Board of Accountancy insulate it from any such conflict with respect to recovery of investigative costs, the justice said.

Review Limited

Flier explained that the law limits the board’s review of the administrative law judge’s ruling on investigative costs to upholding, reducing, or canceling the award; the board cannot award itself more in costs than the ALJ recommends. In this case, the ALJ found that the board had prevailed on 45 percent of its case and recommended that the firm be required to pay 45 percent of the costs, and the board agreed.

The case is thus distinguishable from Haas v. County of San Bernardino, 27 Cal.4th 1017, which held that the part-time hearing officer assigned by the county to hear a license appeal concerning a massage parlor had a conflict of interest because the county was paying him and any future appointments to hear cases would be at the county’s discretion, Flier said.

The justice noted that in the case of KMPG, the ALJ was assigned by the state Office of Administrative Hearings and had no financial interest in the outcome of the case.

The justice also noted that the law limits the board to recovery of prehearing costs; since the accused cannot be held liable for the costs of the hearing itself, the costs provision does not discourage the accused from mounting a vigorous defense, she reasoned.

The case is McBride v. Board of Accountancy, B170613.


Copyright 2005, Metropolitan News Company